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Monday, June 03, 2013

Have you ever helped a friend or a relative by lending your money to them to solve their financial problems especially related debt? If yes, you may want to continue to read on because I don't think you're helping them. You're probably making their financial condition even worst and eventually ruin their life!

Why Lending Money Does Not Work?

The obvious answer is it doesn't solve the root cause of the problem which is due to "lack of financial planning knowledge". If this is not solved, no matter how you help that person, they always come back to you with a same problem again and again. What you really want is "teach him/her how to solve their own problem!" so that they're independent enough to solve their financial problems next time. This solution is forever and will last. :)

So, don't straight away lend your money first...

Explore Alternatives Instead

Although it seems like lending your money is the only solution and it is often not the case. The first thing that what you need to do is guide them ask themselves this question - "if no one is going to help you, what else can you do"? Explore the alternatives together with them. Here are some I can think of:

List down all expenses and see which one can be cut down. Insurance is the tricky one because often being understood as necessity which is not true especially when one fails to pay their own debts. Let it go although it is a lost (due to insurance is not mature yet) and start thinking to switch them to term-life insurance if really need to be insured. Know more about term-life insurance, visit here. I talked about it at very high level. :)

Start looking at their assets and see which one are not necessary. If the debt interest is 15%, can the assets generate 15% of return? If no, then it is probably time to let go of these assets. Sell them and use the money to pay the debts to reduce the principal. Some time you need to force them to sell. :) Assets are those include houses, properties, real estates, cars and investments (e.g. unit trust and stocks).

Get a spreadsheet to work out a monthly cash flow. Make sure it is not deficit, your expenses cannot be more than your income. If yes, you need to redo the above 2 steps. Find a way to make it surplus (i.e. income more than expenses). Put 10% of your income for saving and the rest is the remaing amount (after deduct all your expenses) that you can use to pay your monthly debt installment, let's say RM 1K.

Finally, look for AKPK (specific to Malaysia only) to reduce debt interest. The good thing about AKPK is it stops them from accumulating more debts immediately. I documented down the whole AKPK application process here for your reference. Use this RM 1K as your negotiation with the counselor on amount of money that they can pay in order get an optimum reduced interest rate.

You Still Can Lend Them Money

Ultimately, you shouldn't lend your money if possible but sometime no choice. :)

You still can lend them money only after a proper financial planning has been done on how and when the debt can be settled. In other words, a sustainable plan needs to be came out first. Your money should be a minimum amount money that able to help them have surplus cash flow starting from now for example. Don't lend them more than that.

For the money that you lend to them, I would suggest you charge them interest rather than giving them zero interest and ask them to come out a proposal on how they can pay you back. Your money should be included as one of their debts in their financial planning. From this exercise, you can assess how much they know about financial planning.

If it is negative, the problem is not solved yet. You need to pay more effort. It is not easy to get everyone understand financial planning. Good luck!